The P/E ratio, explained. What a good multiple really means.

This article is educational and general. It explains how a common valuation ratio works and where it misleads. It is not personalised investment advice, and nothing here is a recommendation to buy, sell, or hold any security. Market figures are stamped with their date and will drift.

The price-to-earnings ratio is the most quoted number in investing and one of the most misread. A P/E of 30 can be cheap and a P/E of 8 can be expensive, depending on what the earnings are about to do. This piece covers the formula, the variants, what a “good” P/E really means, and why our own ranking system deliberately does not use it.

The short version. The P/E ratio is a stock’s share price divided by its earnings per share (equivalently, market capitalisation divided by net income). It tells you how many dollars investors pay for one dollar of annual profit. A $60 stock earning $2.00 a share has a P/E of 30. There is no universal “good” P/E: the S&P 500 has averaged roughly 16 on trailing earnings since the 1870s, but a fair multiple depends on growth, interest rates, and sector.

What is the P/E ratio?

The P/E ratio measures the price the market is paying for a company’s earnings. The SEC’s investor education site, Investor.gov, describes it as a way to gauge whether a stock price is high or low compared with the stock’s own past or with other companies, calculated as the current share price divided by earnings per share over the past twelve months.

Read it as a payback number: a P/E of 20 means investors are paying $20 for each $1 of current annual earnings. If earnings never grew and all of them were paid out, it would take twenty years to earn back the price. Earnings do change, of course, which is exactly why the ratio is a starting point and never a verdict.

How do you calculate the P/E ratio?

There are two equivalent formulas. Per share: P/E = share price ÷ earnings per share (EPS). Whole company: P/E = market capitalisation ÷ net income. They give the same answer because both the numerator and the denominator are simply multiplied by the share count.

A worked example with a hypothetical company:

1. Net income over the last four quarters: $500 million.
2. Shares outstanding: 250 million.
3. EPS = $500m ÷ 250m = $2.00.
4. Share price: $60. P/E = $60 ÷ $2.00 = 30.
5. Check with the whole-company formula: market cap = $60 × 250m = $15 billion; $15bn ÷ $500m = 30.

In practice, data vendors usually use diluted EPS (which counts options and convertibles as if exercised), and the choice of which earnings figure to use matters more than the arithmetic, as the next sections show.

Forward P/E vs trailing P/E: what is the difference?

Trailing P/E uses the last twelve months of reported earnings; forward P/E uses analysts’ consensus estimate of the next twelve months. Trailing is factual but backward-looking. Forward is relevant but is a forecast, and forecasts are revised.

Continuing the example: if analysts expect EPS of $2.40 next year, the forward P/E is $60 ÷ $2.40 = 25, lower than the trailing 30 because earnings are expected to grow. The gap can be large at the index level too. FactSet’s Earnings Insight of 16 October 2026 put the S&P 500’s forward 12-month P/E at 19.0 (against a five-year average of 19.8 and a ten-year average of 19.1) and its trailing 12-month P/E at 26.0. Always check which one a quoted figure is before comparing it with anything.

What is earnings yield?

Earnings yield is the P/E turned upside down: EPS ÷ price, expressed as a percentage. A P/E of 30 is an earnings yield of 1 ÷ 30 = 3.3%; a P/E of 10 is 10%.

The inverse has two practical advantages. It can be compared directly with bond yields and cash rates, and it behaves sensibly when earnings are tiny or negative: a company losing money simply has a negative earnings yield, whereas its P/E is undefined. That is why academic studies usually sort stocks on E/P rather than P/E.

What is a good P/E ratio?

There is no single good P/E. A multiple is only “good” relative to the company’s growth, the riskiness of its earnings, prevailing interest rates, and what similar companies trade at. The most useful anchors are history and peers.

The long-run market average. Using Robert Shiller’s long-run S&P data (as compiled by multpl.com), the S&P 500’s trailing P/E on as-reported earnings has averaged about 16.2 since the 1870s, with a median near 15. As of 20 October 2026 it stood around 26. The extremes are instructive: the series peaked at about 124 in May 2009, not because prices were high but because crisis write-downs had crushed reported earnings. A sky-high P/E can describe a collapsed denominator rather than an expensive price.

A sensible way to judge a single stock is to ask four questions in order: How does it compare with its own history? With its direct peers? With its expected growth (see PEG below)? And how reliable are the earnings being divided into the price?

Why do P/E ratios differ so much by sector?

Sectors trade at different multiples because their earnings differ in growth, cyclicality, and capital intensity. Comparing a bank’s P/E with a software company’s tells you little; comparing it with other banks tells you more.

Note the cyclical trap built into this table. For commodity producers and other cyclicals, P/E often looks lowest at the top of the cycle, when earnings are peaking, and highest near the bottom, when earnings have collapsed. Reading the ratio naively gets the cycle backwards.

What happens to P/E when earnings are negative?

When a company loses money, P/E is undefined, and most data providers show it as “N/A” or “NM” (not meaningful). A negative P/E is not a very cheap stock; dividing a positive price by a loss produces a number with no valuation meaning.

Near-zero earnings are almost as troublesome: a company earning one cent a share on a $50 price shows a P/E of 5,000, which says only that earnings are close to zero. For loss-making or barely profitable companies, analysts switch to earnings yield, price-to-sales, enterprise value to EBITDA, or forward estimates several years out.

What is the PEG ratio?

The PEG ratio divides the P/E by the expected annual earnings growth rate (in percent): PEG = P/E ÷ EPS growth. It tries to put fast and slow growers on the same footing. Peter Lynch popularised it in One Up on Wall Street (1989), arguing that a fairly priced company’s P/E roughly equals its growth rate, a PEG of about 1.

In our example, a trailing P/E of 30 with 20% expected growth gives a PEG of 1.5. The caveats are real: the growth input is a forecast, the time horizon is arbitrary, and the ratio ignores risk, interest rates, and how long growth can last. A PEG of 1 on a company growing 40% for two years is not equivalent to a PEG of 1 on one growing 10% for two decades.

What is the Shiller CAPE ratio?

The cyclically adjusted P/E (CAPE, or P/E10) divides the index price by the average of the last ten years of inflation-adjusted earnings. John Campbell and Robert Shiller showed in the Journal of Portfolio Management (1998) that valuation ratios like this have had meaningful power to forecast long-run (ten-year) market returns, though almost none over months.

Per multpl’s daily estimate built on Shiller’s method, the S&P 500 CAPE was about 40.9 on 20 October 2026, against a long-run average near 17.4 since 1881 and a record of about 44.2 in December 1999. High CAPE readings have historically been followed by below-average decade returns on average, but they are poor timing tools: the ratio can stay elevated for years, and changes in accounting rules, buybacks, and sector mix complicate comparisons with the 1920s or 1950s.

Why a low P/E can be a value trap, and a high P/E can be justified

A low P/E is cheap only if the earnings hold up. A value trap is a stock whose low multiple reflects earnings that are about to shrink: a disrupted business model, a cyclical peak, a debt problem, or a one-off gain inflating the current number. The market is often pricing the next year’s earnings, not last year’s.

The reverse also holds. A company compounding earnings quickly can grow into a high multiple: if EPS doubles, a P/E of 40 at an unchanged price becomes 20. High multiples are justified when growth is durable, returns on capital are high, and reinvestment opportunities are long. They are punished, often severely, when growth disappoints, because both the earnings and the multiple fall together.

How do interest rates affect P/E ratios?

Higher interest rates generally push P/E ratios down, and lower rates push them up. A stock is worth the present value of its future cash flows; a higher discount rate shrinks that present value, and investors can earn more from bonds, so the earnings yield stocks must offer rises (meaning the P/E falls).

The effect is strongest for long-duration growth companies, whose cash flows sit far in the future. That is the main reason growth stocks tend to suffer most when rates rise quickly, a mechanism we unpack in interest rates and stocks. Comparing the market’s earnings yield with the ten-year Treasury yield is a popular shorthand, but the relationship is loose and has not been a reliable timing signal.

GAAP vs adjusted EPS: which earnings are in the P/E?

The same stock can show very different P/E ratios depending on whether EPS is measured under GAAP or on the company’s “adjusted” basis. Adjusted (non-GAAP) EPS typically strips out items such as stock-based compensation, amortisation of acquired intangibles, restructuring charges, and impairments, which usually makes earnings higher and the P/E lower.

Since 2003, the SEC’s Regulation G (adopted under the Sarbanes-Oxley Act) has required companies that publish non-GAAP measures to present the most directly comparable GAAP figure and a reconciliation between the two. Read that reconciliation. Recurring “one-off” charges are a cost of doing business, and a forward P/E built on adjusted estimates is not comparable with a trailing P/E built on GAAP results.

Does buying low-P/E stocks work? The value-factor evidence

Historically, yes on average, with long and painful exceptions. Sanjoy Basu (Journal of Finance, 1977) studied NYSE stocks from 1957 to 1971 and found that low-P/E portfolios earned higher risk-adjusted returns than high-P/E portfolios, a challenge to the efficient market hypothesis of the time.

Eugene Fama and Kenneth French (Journal of Finance, 1992) then showed that size and book-to-market together captured the cross-sectional return patterns associated with beta, leverage, and earnings-to-price ratios. In other words, the P/E effect is largely one expression of a broader value premium. That premium has been volatile, with a long stretch of US underperformance after 2007, which is why it is best thought of as a risk factor rather than free money. We cover the family of factors in factor investing.

How Shishin relates to P/E: we deliberately ignore it

Shishin’s daily board ranks roughly 1,000 US stocks on eight scoring components, and every one of them is built from price, volume, and trend. No P/E, no earnings yield, no dividend yield. That is a design choice, not an oversight, and it follows from a simple point: valuation and momentum answer different questions.

• Valuation asks: what am I paying for this business’s earnings, and is that price reasonable over years?
• Momentum asks: what is the market actually doing with this stock now, and is that behaviour persisting?

The research supports treating them as separate. Asness, Moskowitz and Pedersen (Journal of Finance, 2013) found value and momentum returns negatively correlated across many asset classes, which is why they combine well in a portfolio and why mixing them inside a single score tends to blunt both. Our scores stay on one side of that line; the logic is in composite scoring and momentum investing explained.

A practical consequence is worth stating plainly. The stocks that top breakout and momentum lists, including the setups Suzaku looks for, are frequently high-P/E names: strong price trends often accompany strong earnings growth and expanding multiples. A reader who filters a momentum list for low P/E will usually remove most of it. Neither view is wrong; they simply measure different things, and a reader who cares about valuation should check it separately rather than expect the board to do it. Entries on the board fill at the market close, stops are volatility-aware, and every signal is paper-traded in public with misses shown on the track record and logged on the verification page.

Common P/E mistakes and honest limits

• Mixing trailing and forward. A forward 19 and a trailing 26 can describe the same index on the same day.
• Comparing across sectors. A bank at 14 and a software firm at 35 may both be fairly priced for their economics.
• Ignoring the denominator. A P/E spikes when earnings collapse and looks cheapest at cyclical peaks.
• Ignoring debt. P/E looks only at equity. Two companies with the same P/E can carry very different balance-sheet risk; enterprise value multiples account for it.
• Trusting adjusted EPS blindly. Check the GAAP reconciliation.
• Using P/E or CAPE to time the market. Valuation has predicted ten-year returns far better than next-year returns.

The P/E ratio is a useful, compact summary of what investors expect. It is not a price target, and it says nothing about when a price will move. That is the honest scope of the number.

Sources & further reading

• Investor.gov (U.S. SEC), Glossary: price-earnings ratio.
• FactSet, Earnings Insight, 16 October 2026 (forward, trailing and sector P/E ratios).
• Robert J. Shiller, online U.S. stock market data; series via multpl: S&P 500 P/E and multpl: Shiller P/E (accessed 21 October 2026).
• Campbell, J. Y. & Shiller, R. J. (1998). Valuation Ratios and the Long-Run Stock Market Outlook. Journal of Portfolio Management, 24(2), 11 to 26.
• Basu, S. (1977). Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis. Journal of Finance, 32(3), 663 to 682.
• Fama, E. F. & French, K. R. (1992). The Cross-Section of Expected Stock Returns. Journal of Finance, 47(2), 427 to 465.
• Asness, C. S., Moskowitz, T. J. & Pedersen, L. H. (2013). Value and Momentum Everywhere. Journal of Finance, 68(3).
• U.S. SEC, Release 33-8176: Conditions for Use of Non-GAAP Financial Measures (Regulation G, 2003).
• Lynch, P. (1989). One Up on Wall Street. Simon & Schuster.
• Factor investing: size, value, momentum and quality.
• Interest rates and stocks on why rising rates compress growth multiples.
• Momentum investing explained and composite scoring for the price-based side of the ledger.

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